Will the UK state pension system survive ?

 

The problem

Apart from the quite wealthy sections of society, the UK state pension is a vital cornerstone of most Brits' retirement plans.  But the system is set to come under increasing pressure over the next few decades and some expect collapse - either benefits cut dramatically below survival levels or pensions paid for by massive government borrowing that unleashes inflation which cuts everybody's income.  The problem is not just that there will be more pensioners needing provision; it is more subtle and more serious than that.  This article takes a look at the problem and assesses the validity of some of the gloomier predictions of ruin.

The strains on the system

Everyone knows that Western societies are ageing rapidly and that the UK is no exception.  This is the core of the pensions provision problem: proportionally more people drawing a pension. The problem is often described as one of too few workers supporting too many pensioners.  This phenomenon can be expressed as a dependency ratio : the proportion of over 65s compared to the total number of 15-65 year olds.  The UK's dependency ratio, which was 24% in 2000, is foreast to rise to nearly 40% by 2050.  Some European countries,  including Spain, will see much sharper rises in their "oldie" ratos.  Italy is looking at 68%.

A cold look at the stats reveals more bad news in the details.  Not only will there be proportionally more oldies, they themselves will be getting older as a group.  Look at this assessment from a government report:

"One notable trend is past and projected ageing within the pensioner population. In 1971,

persons aged 65+ comprised 13.2 per cent of the total UK population, and persons aged 80+

comprised 2.3 per cent of this total. By 2000, the 65+ population had grown to 15.6 per cent of the

total, but the 80+ population had almost doubled its proportionate share to 4.0 per cent. Over the 50

years to 2050, the Government Actuary’s Department projects that the 65+ age group will have

expanded to 24.4 per cent of the total UK population, but that the 80+ age group will have more than

doubled to reach 9.1 per cent of this total."

The implication is that it's more than a pension issue: there will be a lot of pensioners at the older end of the spectrum who need more healthcare and home help.

Another issue is the cost of "gold-plated" pensions promised to public sector workers that the papers have been making a fuss about in recent years.  Already the government pays public sector retirees £4bn more each year than it collects from current employees in contributions; this gap is set to widen to £14bn annually within the next 6 years.  Public sector workers mostly receive pensions based on their final salary; a level of generosity which can only be dreamed of in the private sector where the norm is for pensions based strictly on what has been contributed over the years.  The government is likely to make public sector employees pay more in contributions and wait longer for their pensions which may be based on average lifetime salary (not the higher one they finish with).

Regardless of this proposed public/private sector demand, it seems that most people are looking to the government to provide for their retirement.  Most experts reckon the majority of Britons save far too little for their old age and, as this article makes clear, it is often women who have less put aside:

http://www.guardian.co.uk/money/2010/oct/19/women-pensions-poverty-retirement

In summary then we have a society that has not saved enough privately to pay for their retirement, remorselessly worsening demographic trends and a government that has undermined private pensions while promising to pay too much to its own workers.  And then there's the current mountainous public sector deficit before any of these bills arrive . . .

Hold the doom and gloom - some counterarguments

We are all doomed then?  Maybe.  It's easy to see the NHS, social services and the government finances buckling under the remorseless strain of demographic trends.  No one knows just how much public spending will need to rise because it is not possible to forecast how public policy and private trends will unfold.  Perhaps people will start saving more.  The government will probably get more stingy and water down the benefits it is promising, for example by making us all wait longer for our pensions (that's already started with a move to 66 factored in and a further move to 68 under consideration).

But it's also true that the dependency ratio overstates the scale of the problem.   Looking at the number of retirees compared to workers only looks at part of the equation.  For one thing a lot of people reaching retirement age carry on working and, with the right government tax and pension polices, this could be a trend that is made more pronounced.  When I was young I harboured ambitions of retiring early but as I get into middle age the idea of an extended working life is not so terrible, depending on my state of health.  If government, employers and social attitudes encourage it, people will work longer and this will be win/win from the dependency ratio point of view, as there will be simultaneously more tax paying workers and less people drawing pensions.

Additionally the dependency ratio takes no account of children who are just as much dependents as pensioners.  There will be proportionally fewer children so this will actually work to relieve the burden on people of working age and the government will have to pay less for education and other child related expenditures.

The UK's controversial policy of allowing large scale immigration from Eastern Europe and elsewhere could also improve the demographic picture with more young people and a boost to the birth rate.  This is the conclusion of the Independent in a recent article  Demographic Trends That Speak Well of Britain

CONCLUSION

I am more persuaded by the negative arguments than the positive ones.  It is not so much the size of the challenge - which is enormous and truly frightening - it is that I don't believe our political system will deliver the right policies to deal with it.  This issue has been looming for decades and any sensible government would have:

 

- encouraged a robust private pensions system

- encouraged savings generally

- allowed controlled immigration to increase population in a sustainable way with people who are skilled and willing to contribute to rather than drain the system

- cut down the promises made to public sector workers to make them comparable with private ones

- introduced compulsory pension contributions for people who refuse to make any provision for themselves

- encouraged employers and individuals to be more accepting of older workers and longer working lives

- ran public sector surpluses to make sure the UK's finances had the reserves to deal with the fiscal challenge ahead

As far as I can see successive governments (especially the last Labour one) have done practically the opposite of all of this.  In particular the last government's attacks on company pensions, running deficits in boom years and destroying the culture of savings did enormous damage.  The current administration has made tentative steps to sort out the mess but I fear it will be too late to save the system.  I suspect there will come a time when the public finances collapse under the strain of unsustainable trends and a tidal wave of inflation impoverishes all but the well-off and well-prepared (like the 70s but worse).  The lesson :  save more privately, don't rely on the government and invest in inflation hedges like precious metals and inflation-linked bonds.

Other economics articles on this site:  Spanish economic crisis takes a new twist Why Spanish property prices are not about to rise

Tax articles on this site (for a full list click on the Advice tab)   Do you need to do a Spanish tax return? Non resident taxes / form 210